Indian iron ore miners have always shown a distinct preference for trade in the spot market rather than entering into yearly contracts with their clients on benchmark rates. This is despite the fact that for nearly four decades,

the major part of the global iron ore trade is conducted on annual
benchmark prices decided after weeks of keenly contested, if not
acrimonious, negotiations between the world’s leading mining groups and
steel makers.

China, which by far was the biggest destination of our ore exports
(101.4 million tonnes last year) and continues to be so this year, is
mightily unhappy that our miners would not agree to trade on benchmark
consideration. Better off we are because of this resolve. Were not spot
prices commanding a premium of over $100 a tonne at one point last year
over the benchmark rates? Today also when the chips are down for the
steel industry, spot ore sales are fetching a premium of at least $15 a
tonne.

According to RK Sharma, director general of Federation of Indian
Mineral Industries, China Iron and Steel Association (CISA) has
launched a campaign for the abolition of spot trade in ore. To make it
a success, CISA must rein in the growing number of speculative
importers in the country. CISA, which has a membership of 72
representing three quarters of Chinese steel capacity of over 600
million tonnes, wants the number of licensed importers to be cut
drastically from the now active 112.

The Chinese association will try to lay the blame for the emerging
vibrant spot market, now naturally catching the fancy of miners,
largely at the door of small and medium Chinese steel makers. Whatever
it is, the Chinese body now has to reckon with the world’s largest
miner, BHP Billiton, announcing that a third of its customers are
henceforward to buy ore based on a new price system linked to the spot
market. No doubt the BHP deal steals the thunder from CISA, which now
appears to be on a mission doomed to failure.

Mind you, the BHP move has come at a time when CISA representing the
Chinese steel industry in this season’s ore price negotiations is being
rebuffed by the trio of Vale of Brazil, BHP and Rio Tinto over its
demand that the benchmark price be cut by up to 45 per cent. Citing the
fact that China alone accounted for a little over half of last year’s
world iron ore imports of 882 million tonnes, CISA says the country
should get a better benchmark deal than the 33 per cent price cut
earlier conceded to South Korean and Japanese steel makers.

It will be premature to see in the BHP announcement the beginning of
the end of the more than 40-year-old benchmark system. In a highly
bullish market caused by strong demand for ore as we saw till the third
quarter of 2008, benchmark prices would cease to reflect market
reality. But for the stability it lends to the market at other times,
the benchmark system finds support beyond steel makers from Vale, the
world’s largest ore producer, and Rio.

BHP CEO Marius Kloppers is almost singlehandedly pursuing the mission
to change the traditional pricing mechanism of iron ore under which
benchmark prices for a season would depend on the relative bargaining
strength of the two contending parties – miners and steel makers.

Kloppers believes that the new BHP contracts linked to spot market are
pointers to “continued progress towards transparent pricing”. As much
as 30 per cent of the company’s total iron ore volumes will henceforth
be sold on a mix of quarterly negotiated pricing, spot clearing price
and index-based pricing.

Commodity watchers think Kloppers’ move will turn out to be a watershed
in the way iron is traded. At the same time, steel makers will see to
it that the benchmark system co-exists with spot market sales. Last
year, of the world ore production of 1.7 billion tonnes, physical sales
were 180 million tonnes only.

No doubt, as CLSA points out, the cost for steel makers on account of
ore would have been around 50 per cent more in the period since 2005,
had they been paying spot prices instead of benchmark prices. Unwilling
to lose revenue on account of benchmark sales, BHP is making a break
with tradition.

Source: Business Standard

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